Did Macro Kill Crypto? with MacroAlf

Alf is the former head of a $20B investment portfolio, a passionate global macro investor, and the author of a free newsletter called, “The Macro Compass," available on Substack. On this episode, Alf helps us understand macro in a digestible way. What’s in our potential future? How bad will it hurt? How long will it last? Answers to these questions and much more in the interview. ------ 📣 Earnifi | Check For Your Unclaimed Airdrops, POAPs, & NFTs https://bankless.cc/earnifi ------ 🚀 SUBSCRIBE TO NEWSLETTER: https://newsletter.banklesshq.com/ 🎙️ SUBSCRIBE TO PODCAST: http://podcast.banklesshq.com/ ------ BANKLESS SPONSOR TOOLS: ⚖️ ARBITRUM | SCALING ETHEREUM https://bankless.cc/Arbitrum ❎ ACROSS | BRIDGE TO LAYER 2 https://bankless.cc/Across 🦁 BRAVE | THE BROWSER NATIVE WALLET https://bankless.cc/Brave 💠 NEXO | CRYPTO FINANCIAL HUB https://bankless.cc/Nexo 🔐 LEDGER | NANO HARDWARE WALLETS https://bankless.cc/Ledger ⚡️FUEL | THE MODULAR EXECUTION LAYER https://bankless.cc/Fuelpod ----- Topics Covered 0:00 Intro 8:00 What to Know About Macro 11:03 Tiers of Money 13:07 Deflationary Timeline 15:20 The Housing Market 17:33 The Inflation Remedy 19:54 Indicators 23:10 Global Credit Impulse Cycle 30:25 Can We Have a Soft Landing? 34:50 How Bad Will This Hurt? 39:29 Volatility in the Bond Market 52:18 Switching to Crypto Assets? 55:57 DXY 1:02:09 Bond/Crypto Market Cycles 1:05:30 What Will Make the Fed Pivot? 1:09:36 The Long-Term 1:15:45 Probability & Adapting 1:19:08 Generating Productivity 1:22:27 The Internet’s Unlock 1:23:40 Why Macro is Important 1:25:40 Action Items & Disclaimers ------ Resources: MacroAlf https://twitter.com/MacroAlf The Macro Compass https://themacrocompass.substack.com/ Is It 2021 Again? https://themacrocompass.substack.com/p/back-to-2001#details ----- Not financial or tax advice. This channel is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This video is not tax advice. Talk to your accountant. Do your own research. Disclosure. From time-to-time I may add links in this newsletter to products I use. I may receive commission if you make a purchase through one of these links. Additionally, the Bankless writers hold crypto assets. See our investment disclosures here: https://www.bankless.com/disclosures

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:02Ryan Sean Adams?

  Thankless Nation, welcome to another State of the Nation. Very important topic, a topic that is top of mind for, I think, everyone in crypto right now. Did macro kill crypto? Can crypto recover? As crypto investors, what do we need to know about the macro environment? Is this going to be like 2008 all over again? Maybe something worse? What happens to our risk on assets like crypto? When are they going to recover? All right, so who's our guest today, David?

• 0:26David Hoffman?

  The guest on the show today, Ryan, is this guy named Macro Alf, who runs a macro-focused newsletter called The Macro Compass. And he has produced some of the most just well-reasoned and thoughtful macro analysis that I've seen in the last six months or so. And it really, to me, answers the question, what does it take? What does, what needs to happen for risk on assets, our precious crypto assets, to reach all-time highs again? What needs to happen before that happens? And the answer, Ryan, is kind of a lot of things. And so we go through that in the show today. And like all of the things that we need to get past in order for us to accept risk again as like, not just like investors in the crypto world. We all already accept risk.

• 1:10David Hoffman?

  But what does it take for the rest of the world to also accept risk? Because that's what it's going to take for them to come back and pay attention to the crypto industry. And so that's really what we're diving into here on the show, Ryan.

• 1:21Ryan Sean Adams?

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• 1:41David Hoffman?

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• 2:17Ryan Sean Adams?

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• 2:29David Hoffman?

  I found four Uniswap airdrops like three months ago because of Earnify.

• 2:35Ryan Sean Adams?

  This is crazy. And what I love about this too is it's zero spam. I mean, they really focus on the quality drops here and skip all the fake drops. So go check that out. There's a link in the show note, bankless.cc/earnify. You spell that, E-A-R-N-I-F-I. You can find out more about this. All right. So David, we're going to get into this episode. What should people pay attention to as we talk to Macro Elf?

• 2:59David Hoffman?

  So this episode with Macro Elf is one part Macro Elf telling us the current state of macro markets, which is useful, but it's also one part a classroom. And so I learned a lot while doing some of my research for this episode with Macro Elf. And he's just a great educator that is simultaneously teaching us about how the macro world works as he's also telling us about how it is right now. And so listeners should just kind of pay attention and like be prepared to get your learn on about, you're going to learn about the structure of macro markets and you're going to be able to understand the answer to the question, what will it take for the world to go risk on again? Because he talks about the economy as a pyramid and how the bond market is at the very bottom

• 3:41David Hoffman?

  of the pyramid. We really need to make sure that bond market does okay if we want people to go risk on. And so listeners should pay attention to that. Like, there is a structure here in the way that the global macro economy works. And Macro Elf just really lays it out what that structure is and what the state of that structure is and how it's going to change in 2023 and 2024. And one day, it'll finally change in our favor, but things need to happen first. So pay attention to all these details.

• 4:08Ryan Sean Adams?

  Guys, let's level up on macro, but before we get into the episode, we want to thank the sponsors that made this possible.

• 4:13David Hoffman?

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• 4:55David Hoffman?

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• 5:40David Hoffman?

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• 6:25David Hoffman?

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• 6:35Ryan Sean Adams?

  Bankless Nation, super excited to introduce you to our next guest, Elf, Macro Elf, that is. He is the former head of a $20 billion investment portfolio. He's a passionate, global macro investor, and he writes a free newsletter, which I think is the best in the game in terms of keeping up with macro. It's called The Macro Compass. It's available on Substack, publishes every week. Elf, thanks so much for joining us at Bankless today.

• 6:57Speaker 02

  Hey, Ryan, David, nice to be here. Thanks for inviting me.

• 7:01Ryan Sean Adams?

  Elf, I think we need some help here, okay? Because we need to learn a little bit more about macro on Bankless. We've done a number of macro episodes, people like Luke Graham and Lynn Alden, Jane Bianco, et cetera. And macro is actually a focal point, I think, for crypto right now. And I'm wondering if you could, Elf, help us through some of these topics, some of these things, but also put yourself in the position of a typical Bankless listener. So someone who's maybe a macro novice but dangerous, knows some of the terms, is kind of financially oriented, but doesn't know all of the details of how bonds work. For, for instance, they're going to have some assets in crypto, right? Because they're listening to Bankless, and how can you not? They're also going to have some traditional assets. Maybe they're worried about the future right now.

• 7:46Ryan Sean Adams?

  Things seem uncertain, got all sorts of things going on politically, globally. 2022 has been a tumultuous year, and maybe they're worried about their portfolio, worried about their money as well. So can you start us with the high level here? What do Bankless listeners need to know about macro? What's going on right now?

• 8:09Speaker 02

  So, Ryan, what they should know is that macro is long-term trends and cycles that intersect with these trends. And people shouldn't confuse the two. So right now, we're in the middle of a very strong cyclical slowdown. Long-term trends, we can debate about those later. But first and foremost, right now, the cyclical macro environment we are, will dominate the trend for the next year or two. And the cycle I'm discussing is a cycle that is diametrically opposite to the cycle we have seen in the second half of 2020 and in 2021. Where both financial money, and we will define money later on, but financial liquidity,

• 8:51Speaker 02

  as it's mostly called by commentators, was thrown at financial actors at an unprecedented pace, and the fiscal authorities made sure that real economy money, the one that reaches our bank deposits actually, was also increased at one of the fastest paces ever recorded under my metrics. That was the dual real economy money and financial economy money that was thrown at the system at once at a very fast pace. And that led to the very sharp nominal growth increase that we have seen in 2021 and inflationary pressures we are seeing now upcoming in 2022. But remember, Ryan, David and the listeners, macro cycles and money generally works with

• 9:36Speaker 02

  a lag. And so as 2020 and 2021, as has happened, and we now see the lagged effects of those, what's happening today, actually, we'll see its lagged effect happening in 2023 and 2024. Some of those lagged effects are already happening, and what effects am I talking about? I'm talking about the effects of reversing the extreme money inundation, financial and real economy money that we have seen in 2020, 2021. So bear with me for a second. You have, when it comes to real economy money, when is the last time that the US government sent checks at home to people? That's April 2021. It's been a year and a half since we have had the last meaningful fiscal impulse in the US.

• 10:20Speaker 02

  I can say the same for Europe. If you look at China, they're deleveraging very, very aggressively at the moment. So the bank accounts, the real economy money of the private sector is now not growing anymore, not nearly as it was in 2020, 2021. What about financial economy money? Well, the Federal Reserve and other central banks are in the process of making sure that that shrinks too, and that's quantitative tightening. It's the process of removing financial economy money, also called liquidity, from the system. So now we're going to be seeing the lagged effects of this double tightening of real economy money and financial money in the second half of this year. We're already seeing that, and then in 2023 and 2024. That's a cycle we will be in going forward.

• 11:04David Hoffman?

  So I think that's a really interesting way to parse apart the two kinds of money in the economy. You're defining two different kinds of money, the money that we as individuals might interact with, the numbers that we see in our bank accounts, the cash that we keep in our wallets, and then what you're calling financial money, which is, I think, just like perhaps like a larger institution money, bank-to-bank money, things inside of what we call like financial system TM. And you're saying in 2020 to 2021, the paradigm was those, both of the supply of those two kinds of monies were just like going up bigly. That's what the paradigm was. And now the new paradigm is the inverse of that, where in 2022 to 2023, we got to pull that, the leadership, financial system has to claw

• 11:48David Hoffman?

  that money back. So we're doing interest rates, the money's got to deleverage the system. And you're saying that there's a lag time between what is happening versus what effects that that will take on the economy. Is that a fair synopsis of what you just said?

• 12:03Speaker 02

  That's a perfect summary, David. And the most complicated part is understanding that there are these two tiers of money. The money that people use, the money that corporates use, is not necessarily the same money that financial institutions use, banks use, pension funds use, asset managers use. That's a financial form of money. 2020, 2021 was a combination of both tiers of money going through the roof. Right now, we have a combination of both tiers of money getting effectively destroyed, or at the very least, the amount of money creation in both tiers actually is slowing down very aggressively. And if you give it nine to 12 months, 15 months in some cases, growth slows down, earnings

• 12:45Speaker 02

  slow down, inflation slows down, risk assets have a problem. And actually, if there is anything that works in those environments, it's mostly cash or very defensive assets. And that's effectively what we have been seeing in 2022, right? That's just the beginning, I would say, of the lagged effects of the double whammy monetary tightening that we are seeing since the very beginning of 2022.

• 13:07David Hoffman?

  So is it fair to claim that because we saw inflation come in with a lagged effect, we had money issuance, money distribution, and then inflation six to 18 months later? You're saying like, well, that same effect of lag time will also happen for deflation. So like, really, the already high-level takeaway is that throughout, up to, maybe throughout 2023 and beyond, we're going to be in a deflationary environment?

• 13:31Speaker 02

  I would expect that there is no valid reason for which cyclically speaking, David and Ryan, as we have seen a nominal growth pickup, so real growth and inflation both picking up in 2020 and 2021 and 2022, we shouldn't see the reverse effect happening, where both real growth and inflation at the same time slow pretty aggressively in a disinflationary trend going into the second half of 2023 and 2024. Remember, you always need to face in a lag. Some of these things work with a lag. The typical example is the housing market and inflation. So if you look at the housing market, basically in 2021, the second half especially, it was incredibly hot, and that's because mortgage rates were very low, that's because people

• 14:15Speaker 02

  had received a boost to their income on top of that, so they had a lot of firepower to go and boost these house prices. Later on, rents also started increasing very aggressively. That was the story of the first, and now even, second half of 2022, when this rent inflation plays into the overall inflation measures that the Federal Reserve is tracking. Now, guess what happens? Mortgage rates have gone to 7%. Incomes are not growing anymore as they used to. In real terms especially, they're shrinking, which makes the housing situation completely unaffordable. So what will happen is that, again, with a lag going into 2023, 2024, house prices are likely to fall, housing activity will fall, jobs will be lost, rents will stop going

• 14:59Speaker 02

  up, and therefore also the housing-related component of the inflation basket will start going down. So again, it takes a little bit of time for this monetary phenomenon to feed into the economy and asset prices, but ultimately with a lag of generally nine to 18 months, depending on what you're looking at, they do feed into real economy activity and asset prices.

• 15:20David Hoffman?

  And you're just using the housing market as a microcosm of many other industries as well, right? Like, maybe it's an easy narrative to explain in the way that, like, okay, housing market was once hot, now it's cooling down, and as a result of that cooling down, we're going to have like a drop off in the housing labor market, and that's going to impact the economy. And I think you're just using this as a story that is probably true of many other industries as well, and perhaps the global economy.

• 15:45Speaker 02

  Yeah, that is correct. So the reason why I'm using the housing market is because it's gigantic, it's because it's intuitive, it's because it's leveraged, and it's because it's on everybody's balance sheet at the end of the day, either via rents, or via mortgages, or owning a house. So it's something that is very familiar, but the housing market represents roughly, together with these ancillary activities in the US, around 15% of US GDP. It's a relatively large sector because of its very, you know, relevant nature for everybody, and because of its leveraged nature. 87% of transactions in the US housing market are backed by a mortgage, which means that interest rates moving up or down, financial liquidity moving up or down, have a very immediate and leveraged impact on the housing market,

• 16:29Speaker 02

  which is also a large portion of the overall economy. That's why I've used it, David, but in principle, I could have made similar assessment for European corporates, or Chinese corporates, or anywhere else. The principle remains the same. If you throw real economy spendable money out, which means you increase the amount of bank deposits that we own, that corporates own, with a lag, will be inclined to actually spend some of this money, boost nominal economic activity, make earnings go up, make the economy grow, which was the story of 2021. Now, if supply is also bottlenecked, then inflation obviously goes up, because the demand is artificially pumped up cyclically while the supply can't be pumped up, and so you also have inflation.

• 17:12Speaker 02

  But now we are reversing that, and we are reversing that very aggressively, not only by stopping the real economy printers, so government deficits in the first place, but also by removing financial liquidity from the system. And that's a job that not only the Federal Reserve, but also the European Central Bank is now keen on doing.

• 17:32Ryan Sean Adams?

  It's really interesting, Alf. So I think a lot of people, they're scared to kind of think about macro or talk about macro because it seems complicated. But what I love about the story that you just painted is it's pretty damn simple. All right, so just to kind of recap, we had this money creation period, both real and financial money, 2020 to 2021. And then nine to 18 months later, we pay for this type or the ramifications of that sort of money creation event start to show up. And we see that in asset prices going up, home prices going up, inflation going up. And that has been the story of the last 24 months. We've seen the effects of that money creation.

• 18:16Ryan Sean Adams?

  Now we flipped and we're in a money destruction period where real and financial money is being destroyed, not being created. It's actually being destroyed. And so what can we expect on the other side of that? Houses prices to fall, asset prices to fall, jobs to be lost, incomes going down. And also inflation going down as well? Will this be the remedy for inflation, do you think?

• 18:41Speaker 02

  Yes. Cyclically speaking, I don't see any major reasons why such a withdrawal of accommodation from the system shouldn't result in the same move down in inflation. And Ryan, this is when I want to stress out that I'm talking about cyclical slowdowns and cyclical pickups. Remember at the beginning when David asked me about macro, you asked me first question about macro. I made the distinction between cycles, cyclicals and long-term trends, right? So we're talking about a cyclical trend here. I would argue that we saw a cyclical upswing in nominal growth and inflation. We're going to be seeing a cyclical downswing now in inflation as well. When it comes to long-term trends, we might open another discussion.

• 19:26Speaker 02

  And also, when you, obviously, when investors look at crypto, look at other asset classes at investment decisions, their time horizon can be very long, especially if they're very young and they want to invest in something for the next five to 10 years. Nevertheless, risk management through micro cycles is very important. So I always want to talk about both. I want to make sure that people have the right frame of thinking when approaching macro. So the trends are maybe a different story, but cyclically speaking, I do expect inflation to slow down, yes, in 2023.

• 19:53Ryan Sean Adams?

  And this money destruction period, it sort of started happening, would you say, at the end of 2021, but definitely into 2022, is that the case? And so this is why you're saying, like, we can expect to pay for that, like, now and for the next, you know, nine to 12 months, nine to 18 months into 2023 and 2024. Is that a rough timeline of this cycle?

• 20:14Speaker 02

  So, so Ryan, I build a metric that encapsulates and proxies the growth in real economy money. So financial money is one tier and real economy money is the other. So I try to measure whether us as the private sector and corporates are actually getting our bank deposits pumped up or not, or to which to which extent is this acceleration of real economy money there. And under that G5, so the five largest economies basically pulled together, that credit impulse metric basically peaked in the fourth quarter of 2021. Now, very punctually, if you ask me, nine months later, so roughly by the half of this year,

• 20:59Speaker 02

  the first half of this year already, we started seeing the first signs of forward leading indicators actually slowing down. PMI service went down, the first cracks appearing a bit in earnings, some companies were more defensive when announcing earnings. Now, we have seen in these earnings releases that Amazon and other large companies are starting to to see some hits when it comes to earnings, right? Those are very large companies, systematically important global companies. You are seeing very evident economic slowdown already. Now, how long does it take for inflation to slow down? That's next leg. And here, Ryan, people should understand that in in macro, there are forward leading indicator, coincident

• 21:39Speaker 02

  indicators and lagging indicators. Now, credit impulse is one of the most forward leading indicators of all. It tells you whether real economy money is being printed or not. And that peaked in Q4 2021, and after that, it's been slowing down. Six months later, survey forward leading indicator, PMI service, ISM service, other service actually start to decline. 12 months later, so round about now, you start to see earnings declining. Next leg to fall is going to be the labor market. The labor market is a coincident indicators. Companies will actually first try to cut discretionary spending and only later on adjust their headcount if they see the economy is slowing down. It's not an immediate process.

• 22:21Speaker 02

  So the next shoe to fall will be the labor market somewhere between next quarter and the quarter after that at the beginning of 2023. And only when the labor market cools down, Ryan, you can have wages cooling down, which means the nominal spending power of people also goes down. They'll need to be more conservative, they'll spend less, the demand side of the economy will get a big hit and inflation will slow down too. Also, the housing market will have slowed by then, which means that with the lag, rent pressures will be slowing down. All of that I expect to happen in the second half of 2023. Until to the point where in 2024, I expect federal funds rate below 1%. And remember, we'll be picking at roughly 5% more or less at the end of this year, beginning of next year.

• 23:04Speaker 02

  I expect Fed funds to be below 1% in 2024.

• 23:08Ryan Sean Adams?

  Wow, that's a big change. I want to actually share this metric that you were just referring to, the global credit impulse metric. And, you know, one question about this cycle. So again, we're still, we're still talking about the cycle. We're not talking about the long term. We'll, we'll talk to some of the, talk about some of the long-term implications. But what I'm now showing is Macra Elf's global credit impulse cycle. And one thing I noticed here, which is kind of a question about this cycle specifically, Elf is, it seems higher, the high seems higher and the low seems lower than previous cycles. This chart goes all the way back to 2004, if I'm correct. And I want to ask you specifically about this cycle.

• 23:53Ryan Sean Adams?

  Has, have the polls, the extremes, the, the rapid upswing and the rapid downswing on all of our numbers been far more, I don't know, I guess the word is maybe volatile than previous cycles? What is unique about this cycle compared to the last? Is this cycle different?

• 24:13Speaker 02

  It's a very smart observation, Ryan, and this cycle was unique for two reasons. The first was the combination of real economy money printing and financial money printing at the same time, which is something that rarely happened in modern history after World War II. And the second thing that made it very unique is that there was an exogenous shock, which was the pandemic, that basically made the foundations of our leverage system tremble. And it trembled because of an exogenous shock, which effectively led to a response which was not very easy to measure. The United States printed over five trillion dollars in real economy money.

• 24:56Speaker 02

  This is government deficit, which means that the government blows a hole in their balance sheet and it throws money at the private sector without taxing them. That's what it means. It's unfunded money spending, and it ends up on the balance sheet of us. It's money that's been spent for us. Five trillion dollars, Ryan. It's 25% of GDP. This is like, this is a warlike fiscal response, and even like a large war, I have to say. So effectively, the exogenous shock was an event where policymakers couldn't really measure the amount of stimulus that was needed. And so they ended up doing too much in certain jurisdictions. The US is a typical example, where this ended up overeating the system.

• 25:41Speaker 02

  And we saw, if you, the chart you pulled up there, have you seen these cycles, these swings, right? You pump up the system and then you drain this money creation. Have you seen what happens to earnings? So those, those orange dots or these blue dots on the chart were actually earnings per share in the S and P 500. So how much the companies are actually growing their earnings year over year lagged by nine to 12 months. So again, give it a little bit of time. Give it nine to 12 months to see the effect of this monetary expansion. Earnings grew by 52% in 2021. This is just gigantic. Now, obviously, when you withdraw now very abruptly that stimulus, what happens is that

• 26:23Speaker 02

  you should expect economic activity to slow down at least proportionally. Also, the other point is that our system becomes more leveraged as we go on. And now we move to discussion a bit to the trends, right? Because so far, we talked about cycles. But the way that our system works is the following. We, after the 80s, we are not able to engineer organic growth anymore. And now, does an economy engineer organic growth? Is via having more people participating to the economic growth, which means labor force growth, good demographics, we have a lot of kids entering the labor force, we have a young population that produces, or, and/or, this population is very productive.

• 27:05Speaker 02

  So it's the productivity of labor and the productivity of capital. If you sum up labor force growth and productivity, you obtain what's called potential growth, which is the organic growth that an economy is able to generate without cyclical boosters, just by its own means. Now, in the 80s, potential GDP growth in the US, according to my estimates, was roughly 4.5%. Every year, the US would deliver 4% real GDP just by its own means. Why? Because demographics was good, population was young, productivity trends were good, et cetera, et cetera. Now, after the 80s, there has been a massive decline in this trend. Demographics has turned against us. The population ages.

• 27:50Speaker 02

  We have much more retirees than new people entering the labor force. In many jurisdictions, over the next 20 years, the labor force will shrink. Think about that. It's like the pie of people contributing to economic growth will become smaller. How can you expect an economy to generate organic growth year after year if there are less people contributing to economic growth? Via productivity, maybe. Yeah, sure, we have had some productivity pickups. But as technology has already widespread pretty aggressively through many sectors, the marginal productivity increase every year becomes a bit more complicated to engineer. We still grow in productivity every year, but we have already done the bulk of, you know, penetrating technological advances through our sectors,

• 28:35Speaker 02

  which means that, if I take Germany, German potential growth, real growth, just looking at demographics and productivity, is roughly 0.7% a year.

• 28:46Speaker 02

  Which politician will accept an economy growing at point seven percent a year? That's like a Japan stagnation kind of environment. So what do we do? Well, we give it a booster. We give cyclical boosters to our economy, which means we create credit. We create debt. We basically lever up our spending power today, borrowing from the future. We lever up our balance sheet. We go to a bank and we ask for a mortgage, a bigger mortgage, a bigger and bigger mortgage to be able to afford a house that otherwise with our means we wouldn't be able to afford. It's credit creation is the process of levering up the entire economy balance sheet.

• 29:27Speaker 02

  And now if you sum the public sector and the private sector balance sheet. If I, if I take total economy debt in China, in Germany, in the U S, in Japan, everywhere I look, we are anywhere between three hundred and four hundred percent of GDP. Because we keep doing the same. We lever up at this round and then we make leverage cheaper. Interest rates are lower at every turn. And now borrowing at four percent allows you to borrow this much, but borrowing at three percent allows you to borrow more and then borrowing at two percent allows you to borrow more, et cetera, et cetera, et cetera. So this is the process we have been ongoing for now four years. And this process is just there to make sure we can supplement very poor organic growth

• 30:12Speaker 02

  with cyclical boosters. And that also explains, Ryan, why you see these cycles being every time, having a higher, a higher top and a lower bottom, basically, because you're trying to lever up the system more and more at every iteration.

• 30:26Ryan Sean Adams?

  Alpha, we definitely want to talk about the, the longer term theme here because it, it does seem like maybe the, the plane is running out of runway, right? I mean, we've tried this act a few times. I, I also want to talk about kind of the. The precision of the cyclical analysis that you're presenting us because I like the simplicity of it, but I also like the kind of the cause and effect nature of it. It's we did this thing, right? And then this is the cause and we see these effects on the other side of things. And so when I hear a lot of people talk about macro, it's all it just much of it seems like very probabilistic, like this could happen and this could happen. But like you're kind of saying, no, this is this is sort of an inevitability.

• 31:10Ryan Sean Adams?

  I'm picturing like a python eating a rat or something, you know, for its breakfast and it bites and then, you know, the rat has to like travel through the rest of its body. And that process might take some time, but that is exactly like it has to get to the into you into the python's body and be totally absorbed by it. And that's just an inevitability. And that's what you're presenting as kind of the cycle. I guess maybe a question to you, though, is, is there any way to avoid this sort of cyclical outcome? Like this talk of soft landings, right? Is this just Fed speak? Is this just banker speak? Or is the plain speak reality that maybe if if central bankers didn't have to put on

• 31:54Ryan Sean Adams?

  an act, maybe they'd just be saying, look, we did some things and we created a lot of money and now we have to absorb the rat, basically. And this is the inevitability of what's going to happen. Let me ask you, is this totally prescriptive or can we get around this somehow? Can we get a soft landing?

• 32:14Speaker 02

  No, we can't. It would be my answer. Now, the issue is, of course, I also think in probabilistic terms, Ryan, and what I described might come across as inevitable, but I managed a very large investment book. I've been proven wrong plenty of times and therefore I am very aware of having to be receptive to the fact that your base case probabilistic scenario might not play out, right? So what I say is what I would my macro models and indicators actually tell me ahead and I assume that to be the base case and that's probably it's coming across as very, very strongly opinionated base case because it is. When it comes to central banks speak,

• 32:58Speaker 02

  that's another of funny experiences I've had the chance of going through when I was running this twenty billion dollar book. Is that when you go and talk to policymakers, to be honest, right? And all they wanna say is what the prescription tells them to say. And the prescription is to come across as very balanced, preserving the status quo and preserving a controllable outcome. That's what they want, right? So if you think about it, I found very impressive that Powell, at the Jackson Hole speech in August, he went outside this normal prescription. I'm quoting him now, at top of my head. He said something like,

• 33:41Speaker 02

  "The pain that households will need to go through to bring down inflation is an inevitable consequence of the process of tightening monetary policy." Now, he's talking about households experiencing pain. That's not central bankers' jargon. Now, Jerome Powell, who's rumored to have redacted his speech completely a few hours before the Jackson Hole speech, is a very strong indication of how uncomfortable policymakers are at this stage. Because not only this is not a status quo environment anymore, not a controllable environment anymore. Not only that, but actually it's way beyond any comfortable zone area,

• 34:24Speaker 02

  which makes them want to move even more than proportionally aggressive. They need to act and put themselves in front of the curve to try and regain that little credibility left before it's totally lost, which makes them wanna, you know, act very, very, very strongly. I saw you put up a screen with these exact words. I'm not sure I quoted him perfectly, but the gist was that one.

• 34:49David Hoffman?

  Alpha, a lot of listeners, both Ryan and I are millennials and so we remember when we were younger going through 2008 and that was my first experience of like, oh, an economy is this thing that can be bad sometimes. And I think that's just like the memory that a lot of Bankless listeners have. When we say that there's this coming era of deflation and depressed market activity and less growth, the only frame of mind I have to compare this to is like 2008 and like the years after that while it took like years and years to recover and produce a normal economy again. How, when we use that as our anchor point, like how, and we talk about households going through pain, how

• 35:32David Hoffman?

  much pain we talking? Like, how are people going to feel? How's the average US economy worker going to feel over the next like two years?

• 35:41Speaker 02

  I expect the US to lose about two to two and a half million jobs next year. That will bring unemployment rate up to roughly five and a half to six percent, which is a pretty high unemployment rate for the US, but if you think about it in historical terms, it's not skyrocket high. Nevertheless, we're at three and a half percent now. To move up to six in one single year, it's quite a lot of pain. The historical parallel that I'd like to draw here, David, is for the older listeners, it's late 2000, beginning of 2001. I wrote an article on the Macro Compass, it's free for people who want to check it

• 36:22Speaker 02

  out, which really compares today with that period. I see a lot of parallels. Now bear with me for a second. In 2000, we saw a dot com mania. Anything that had a dot com after its name was growing, you know, it was basically doubling in share price in a few months. Can we say the same about the excessive risk-taking we have seen in some of the tech stocks, in some of the altcoins, in some of the more risk-intense, risk-taking corners of the market?

• 36:56Speaker 02

  We might wanna say the same, right? We have seen ARK, for example, dropping eighty percent now in basically a few quarters as the result of that stellar increase, that ARK or any other, I'm using ARK, I could use any other high beta, risk-intense asset class out there. Second thing, inflation back then was over four percent for five quarters in a row. Now, today, it's much higher than four percent, but it gives you the idea that inflationary pressures were persistent and way above the Fed target, which also limited the ability that the Fed had to accommodate in case things got worse, because inflation was way above their mandate. We also had, at the end of 2000, the first quarter where earnings started to wobble.

• 37:39Speaker 02

  Does it remind you of anything with a lot of earnings downgrades we have seen today in very large companies? We have seen Meta, we have seen Amazon, you know, we have seen some of these earnings actually starting to wobble. Now, what happened in 2001? Because now, if this parallel works, we're basically looking into 2001 like now we are looking into 2023. What happened is that earnings dropped very materially, ten to fifteen percent in 2001. That's a pretty sharp drop in earnings. In earnings, unemployment rates showed up, and inflation started dropping only later on in 2001, which also allowed the Fed to cut rates by one hundred and fifty basis point in six months.

• 38:24Speaker 02

  Pretty decent cutting cycle, right? So then, what I did is I looked at asset classes' performance. I looked at, okay, what happened when the economy was weakening enough that bad with labor market losses, with earnings dropping, that it forced the Federal Reserve to cut interest rates? What happened to asset classes? Now, equity markets dropped another fifteen percent.

• 38:47Speaker 02

  The dollar kept appreciating even if the Federal Reserve was cutting rates. That makes me think that this Fed pivot that we often hear about that has been so misplaced this year, when and if it happens, it happens probably because things have gotten so bad in the real economy that there is nothing to be happy about the Fed pivot in the first place. Now, there will be a point when the Fed is easing enough and economic damage has already been done and incorporated that we will have a very good buying opportunity for risk assets in general. Another cycle where to basically pick up this lack of what's been left on the table, but I don't expect that to happen anytime soon.

• 39:30David Hoffman?

  And I think I definitely want to get into that conversation with risk assets and their future, but in order to get there, I kind of want to start with the bond market because all things start with the bond market, doesn't it? And there was a tweet that Ryan and I talked about on a couple like Friday weekly rollups ago that the tweet was about, it was a graph that compared the volatility of Bitcoin to the volatility of the 10-year Treasury. And for the first time ever, Bitcoin is less volatile than the 10-year Treasury. And I mean, crypto right now is actually very, very just like volatility depressed. Things are kind of flat right now, so we're in this unprecedented flat moment, but still, the point still stands when like the 10-year Treasury is more volatile than Bitcoin. That's definitely like saying something.

• 40:12David Hoffman?

  And when I first interpreted this tweet, it was kind of like a victory lap for the crypto industry. It's like, look, our industry is becoming more stabilized, it's becoming more mature. Like, we always knew that crypto would become less and less volatile as it got bigger and we're seeing some of those first signs of that. And then after reading your articles and consuming some of your content, I would then realize that perhaps a victory lap of celebrating the volatility of the 10-year Treasury market is not actually the thing to be happy about. Alf, could you walk us through the significance of volatility and spreads in the bond market and kind of what it means for everything else?

• 40:48Speaker 02

  The vital question for investors right now, David.

• 40:53Speaker 02

  The levels of realized volatility in the Treasury market are the highest since the great financial crisis, effectively. And let me walk you through what does this mean for asset allocators. Now, I always like to think in big picture terms, so... Try to picture with me a pyramid. And the pyramid has several building blocks all the way up to the top. And the base, the very base of the pyramid, the layer which is supposed to be the most stable is actually the bond market. With the underlying repo market and all the money markets behind, those are the very bases of the pyramid. Now we are shaking this base very aggressively with this high level of implied and realized volatility. What does this mean? Okay. Who are the whales in the market?

• 41:38Speaker 02

  The whales in the market are institutional allocators, pension funds, banks, you have asset managers, the BlackRock, the PIMCOs, the large pension funds, the sovereign wealth funds, you need to think about those. They have assets under management of several trillions of dollars, trillions of worth of dollars. Okay, so these guys have an asset allocation mandate. They can buy bonds, they can buy equities, they can buy credit, they can buy commodities. The bond market is, bonds are often a decent allocation of these guys. And there are structural reasons why. So if you're a pension fund, imagine that on the liability side, what you need to do is you need, you have this pension premiums, pension contributions, you need to service

• 42:21Speaker 02

  in 20, 30, 40 years for your clients, right? Which makes you prone to interest rate volatility. You have these fixed cash flows, you have to service in 40 years, in the meantime, there will be a lot of interest rate volatility. And you have some returns to make on the asset side to make sure that you can pay these pensions over time. Now, so therefore you need to generate returns and you need to hedge some of this interest rate volatility that happens to hit your liability side. An asset that generates returns and hedges interest rate volatility is a bond. A bond allows you to generate a certain fixed returns, it's a fixed income instrument, and also allows you to hedge this volatility over time. Now that makes a pension fund a natural buyer of bonds. It's a big whale that naturally will be buying bonds. A bank, same story.

• 43:06Speaker 02

  By regulation, banks need to own liquid assets. Liquid assets are assets that can be liquidated very quick or repoed in the repo market and transformed in cash very quickly. So if depositors come all of a sudden and withdraw their deposit very quickly, banks can service these deposits. It basically limits the risk of bank runs effectively. It's new regulation being put after the great financial crisis. Which makes banks big buyers of bonds because the regulator has told them that they need to own liquid assets. Okay, so this, basically, they will be buyer of bonds, naturally speaking, over time. What happens if the asset class they count the most on for fixed returns, stability, low levels of volatility? What happens if that asset class becomes very volatile?

• 43:51Speaker 02

  What happens if the base of the pyramid becomes very volatile? The second, third layers of the pyramid are credit, corporate bonds. They are mortgage-backed securities, equities. They are riskier tranches of this pyramid I just discussed. If the base is very solid, is very stable, pension funds, banks will be looking for additional returns. They will be looking for taking a little bit more risk up the pyramid because the base fulfills all their basic needs. And as that is stable and volatility is very low, they can buy credit spreads, they can buy equities, they can buy mortgage-backed securities. But now make the base shake. When the base shake, obviously, what these investors will do is they will be forced,

• 44:34Speaker 02

  mechanically forced, to divest the riskier investment at the top because if the very base is becoming shaky, imagine what happens at the top of the pyramid, David. So what happens is a natural risk inclination that brings this large whale, large institution, to dispose of their investment portfolios that are the least close to their mandate. Their original mandate is to secure risk-free returns and to hedge interest rate risks, not to go and buy some fancy CLO or weird structured housing market bond to generate a little bit of yield on top. That's okay when volatility is very low, but when volatilities are in the bond market, they pare back their risk. And I've been there.

• 45:18Speaker 02

  I've had the CFOs, I've had risk managers, stopping on your shoulder when things are getting shaky and saying, "Do we really need that Chinese bond that you bought to make 8%? We don't need that anymore. Sell that." So then what happens is a cascading of events where the big whales dispose of their risk assets, puts pressures on price, puts pressures on other investors to dispose of their risk assets, et cetera, et cetera, et cetera.

• 45:44David Hoffman?

  And is this what, the words contraction or deflation seem to just resonate really hard here, where like if we're talking about a pyramid and the foundations of the pyramid are shaking and everyone gets scared, everything is just contracting, everything comes down from the top. And so this is the same conversation as like when we say an economic contraction or an economic deflation, these are the same words.

• 46:08Speaker 02

  Yeah, basically, yes. So you need to imagine that if the base of the system is shaking, the edges, the fringes of the system are the ones hit first. So very leveraged companies, emerging markets that are very reliant on external funding, hey, nowadays not even emerging markets, you can say the same for the UK or Europe. Have you seen where the pound or the euro went? So if you shake the very core of the system, what happens is that the most exposed, the most fragile, the more leveraged fringes of the market tend to suffer first. And that's what we have seen. The second thing we haven't really discussed about is that you can move the base of the pyramid in two ways, really. You

• 46:53Speaker 02

  can make it shaky, make it very volatile, or you can literally withdraw some of the base from the system. Like, have you seen one of these games where you can just withdraw a single stick of wood from one of these towers and you have to still keep it in balance? Yeah, I don't remember the name of the game.

• 47:11David Hoffman?

  Yeah, Jenga.

• 47:12Speaker 02

  But right now, what we are doing is we are withdrawing small pieces of woods from the very base, and those pieces of woods are financial money. We are making sure that the Federal Reserve balance sheet shrinks, but most importantly, that bank reserves, which are money for banks, money for the financial system, is getting withdrawn from the system. So bear with me for a second. So the bond market is shaky and banks have less bank reserves, which are money for banks. Now, these bank reserves, which shrink effectively when the Federal Reserve shrinks their balance sheet, there is a lot of monetary plumbing into that that we can cover if you guys want. But simplistically speaking, if the Fed shrinks their balance sheet, normally, bank reserves will shrink too.

• 47:57Speaker 02

  And when these bank reserves shrink, what happens is that banks have less money for banks. These bank reserves are used to settle transactions with other banks, to do repo market transactions between banks, to buy and sell things between banks. And these bank reserves do never enter the real economy system, never. It's just a separate tier of money. But now you're reducing these reserves. So banks have less liquidity for banks, which means, obviously, at some point, they will be less keen in engaging with a lot of liquidity providing transactions because they themselves have less liquidity for banks, right? So why would I want to share this liquidity with markets? Why would I want to lubricate the repo market?

• 48:42Speaker 02

  Why would I want to be very liquidity providing towards others? The more you shrink this base, the more banks will become more risk averse and more prudent with their liquidity providing exercise. What happens when you dry up markets from liquidities? That you increase systemic risks. Do you remember the 2019 repo blow-off? That was mostly because bank reserves were dropping very, very aggressively as the Federal Reserve was ongoing with quantitative tightening, which reached the breaking point where banks said, "I'm sorry, but I don't have much liquidity, bank money for myself, so I'm gonna completely stand back and not provide liquidity, not lubricate the repo market," which, if you remember,

• 49:25Speaker 02

  is one of the base layer of this pyramid. So we are not only making it shake when it comes to price volatility, but we're also making it Less lubricated effectively by removing the amount of bank reserves from the system.

• 49:38David Hoffman?

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• 52:18Ryan Sean Adams?

  So Alf, let me give you a crypto bro fantasy story here, and I want you to like, you know, bust the bubble or see if there's any truth here. So I think the crypto world sort of sees the base shaking, right? You know, the pensions, the whales, they're looking at their bonds and they're like, "These yields are terrible. I am losing a lot of money on these things." And so the crypto fantasy is that rather than buy more sovereign bonds, for example, they switch out the asset and they start purchasing Bitcoin, they start purchasing Ether, they start swapping into crypto-based assets that aren't backed by nation-state economies, right? This is like a whole fantasy story, hasn't really happened yet, but this is, I think,

• 53:02Ryan Sean Adams?

  what the crypto world hopes for. Maybe not at this stage, but at some stage in the cycle. Alf, you've been in this position. Is there any hint of realism to this type of a scenario? Will they start to look at other assets that aren't based on the bond system, something that is maybe a self-sovereign type of bond or a commodity type of money?

• 53:27Speaker 02

  At the moment, there is none, Ryan, to be honest. Just a fantasy. Just a fantasy. Let me give you an example. A friend of mine would define it Bitcoin for boomers, which is gold. That's the definition he would give to gold Bitcoin for boomers. Gold is something that everybody is familiar with in the policymaking circles. Everybody knows gold. We've even had a gold standard. I mean, it's really something that people are familiar with in that circle, in the regulatory policymaking circle, right? Gold sits on most large central banks and Ministry of Finance balance sheets all over the world as a reserve asset.

• 54:11Speaker 02

  Everybody's familiar with gold, right? Now, if you're a bank and you want to own gold as a form of liquid asset instead of owning bonds, instead of owning bank reserves, you would decide, again, to go outside the system and say, I'm going to own an asset that is a form of money that doesn't belong to that financial system in the first place, that financial design in the first place. Well, that would be something that I guess people would be OK with when it comes to an idea. And again, gold is a concept that policymakers and regulators are familiar with. Yet, gold is treated like, can I swear on this podcast? Sure, totally. It's treated like dog shit by regulators.

• 54:54Speaker 02

  So if you're a bank and you buy gold, you get treated extremely bad from a regulatory liquidity standpoint, so you do not meet your ratios. The regulators are not friendly towards gold as an asset. And on top of that, you cannot even from an accounting perspective get friendly treatments that banks are looking for when owning these very large amounts of liquid assets. And we are talking about gold, again, something that these regulators are very familiar with. Now, try to think about Ethereum or Bitcoin in this context. Right now Ethereum or Bitcoin are basically seen as so-called mark-to-market assets for banks, which means, yes, you can buy it. Nobody forbids you from buying a future maybe or an ETF

• 55:38Speaker 02

  that tries to replicate that exposure. But you are gonna be basically treated as if you're gambling on this asset. This will be treated with no regulatory friendliness at all, no accounting friendliness, nothing. And there is no concrete signal that this is going to change anytime soon.

• 55:57Ryan Sean Adams?

  Wow, so you're saying this doesn't even solve, this doesn't solve the problem for that base layer of whales? Because they can't, they're not even buying gold, this narrative. So to think that they would buy Bitcoin or Ether is just like completely unrealistic.

• 56:11Speaker 02

  But the way you need to think about this is the following.

• 56:15Speaker 02

  The system is regulated and built around,

• 56:23Speaker 02

  let's say, a financial system we have designed and used for now hundreds of years. And that system looks, basically makes use of bonds and makes use of financial plumbing that includes the repo market, bank reserves, shadow banking, et cetera, et cetera, et cetera. That's the prevailing system we have had for at least 100 years. What would be the incentive scheme from regulators? And remember, these regulators are the same guys that I talked about before when I said they want controllable outcomes, they want status quo, they want something they feel comfortable with. What would be the incentive scheme for them to cause a revolution in that system? There is no incentive scheme.

• 57:07Speaker 02

  And I'm not saying it's the right thing to do, to completely ignore this. But again, in macro investing, it's not about what we want to happen. It's about the cards we are given with to play poker with. My mentor always said, "If it's not about the hand you wish you were dealt with, it's the hand you have that you have to try and maximize." And right now, we have an incentive scheme from regulators and policymakers that completely prevents them from looking for creative solutions to these, to these problems you are correctly identifying.

• 57:40David Hoffman?

  Yeah, it's an interesting juxtaposition where all the the theory of like crypto Bitcoin Ethereum is that we want these things to become the new foundations, the new bottoms, the new base of the pyramid. But still, in reality, they are at the very tippy top of this like like scale of risk. And so maybe it's just a little bit too idealistic, a little bit too soon. And Alf, I just want to like check my reasoning about one thing. We've been watching the DXY just climb, climb, climb super strongly. That is because the DXY is a measure of the dollar, which is at the base of the pyramid, right? And so the dollar climbing to new new strengths is indicative. And while Ether and Bitcoin are going down in price, like that's because the dollar is at the base and Bitcoin and Ether are at the top of the pyramid.

• 58:24David Hoffman?

  Like, that's correct reasoning, right?

• 58:26Speaker 02

  You are so right. We talked about the base of the system, looking at it from a very domestic system perspective. If you broaden your perspective to a global pyramid and you look at the base of this global pyramid, you still will find repo markets, the bond market, and you will find the dollar at the very epicenter of this pyramid in the building block. Our system is built around the dollar. Another way to think of it is that the dollar is the denominator of the good stuff and of the problem. So let me try to explain what I mean. The dollar accounts for 10 to 20% of global GDP and world rates. That's it, 10 to 20. I didn't say 80, only 10 to 20%.

• 59:09Speaker 02

  Though, when you look at how much the dollar accounts for as a share of cross-border payments, FX transactions, bonds issued by jurisdictions not in the US that want to borrow in a foreign currency, the dollar accounts for anything between 60 and 80% of these transactions. So what I'm telling you is that, let's take Brazil as an example. Brazil, the exports stuff we need, soybeans, commodities, oil, they export a lot of stuff, right? Now, to grow their business with the world, they basically decided, together with everybody else, to use the dollar as the denominator of their of their transactions. Soybean contracts are in dollar, oil contracts are in dollars.

• 59:53Speaker 02

  Everything that they export basically is denominated in dollars. Now, think of this for a second. If you're a Brazilian corporate and you want to lever up your business, you want to produce more of this stuff, you want to export more of this stuff, you probably will be wanting to borrow in dollars. You borrow in dollars, you can boost your dollar spending activity and you can then export more stuff in dollars. Okay. This is actually what we have done. Emerging market debt denominated in dollars was roughly 2 trillion, somewhere like in 2000, and it's now 6 or 7 trillion dollars. So we have 1.3x on this dollar-denominated emerging market debt. That's all fine and dandy as long as dollars keep organically flowing towards Brazil.

• 1:00:36Speaker 02

  But what happens when growth slows down? And, you know, developed markets don't want many of these soybeans or oil anymore because the economy is slowing down. All of a sudden, Brazil can't sell stuff denominated in dollars anymore to the same extent it could before. Wait a second. They have liabilities in dollars. They have incurred in debt denominated in dollars. So what happens then? What happens is that you go to the core of the pyramid, which is the dollar. The dollar becomes the denominator of the problem and everybody wants to get their hands on the dollar to make sure that they can pay off their debt denominated in dollars because they are not getting these organic dollar flows anymore. So it's a dash to the dollar. It's a deleveraging episode where the denominator becomes the problem.

• 1:01:21Speaker 02

  Everybody wants it. Everybody needs it. And so the dollar goes up in value. And the fringes, as you said, David, the extremes, the things that are the farthest away from being the very core of the system are the ones that suffer the most in that environment. That's exactly what we have seen in 2022. We have seen economies slowing down. We have seen the Federal Reserve making dollar access more tight, more expensive. And we have seen all the fringes. And with fringes, I mean, even the UK, even Europe has become vulnerable to currency depreciation because they are maybe closer to the core, but they are not the core. The epicenter of the global pyramid

• 1:02:05Speaker 02

  is the dollar, the dollar bond market and the repo market.

• 1:02:09David Hoffman?

  So it doesn't sound like, as an investor who lives at the top of the pyramid, if you will, like, most of my net worth is crypto assets. It doesn't sound like crypto assets, risk on assets, the fringes are going to reach new highs until, like, we get over this, like, new paradigm of the market. Like, we are the, if we want, like, new all-time highs in Bitcoin, Ether, all our risk assets, the most bankless listeners have, we need to wait for this bond market to stop being so volatile and for spreads to become smaller, right? And we're just gonna be probably sitting on our hands until that happens. How long? How long are we sitting on our hands for?

• 1:02:48Speaker 02

  So as we-

• 1:02:49David Hoffman?

  What's the trajectory of bond market volatility?

• 1:02:51Speaker 02

  So, we're talking about cycles now again, David. We had a nice discussion about trends and structural drivers of everything. We go back into cycles. So if you look at the timing there, you should expect that the, basically, the double-whemy money contraction plays its lagged effect through the economy in a way that people lose their job, I'm gonna say that very openly. So unemployment rate goes up, inflation slows down, and the Federal Reserve can accommodate and make sure that it lubricates the system again, and that the government as well can become a bit more lenient in their fiscal stance all over again. And then you're again back into the moment where both layers of money actually are thrown

• 1:03:35Speaker 02

  to the system, not withdrawn, but they're thrown to the system. Once that happens, you allow a little bit of a lag and risk sentiment will be building up again. So, these cycles generally take roughly one and a half to two years, which means you are already in the cycle itself. You have seen Bitcoin, Ethereum, all major crypto and digital assets take a drawdown, which was to be expected, and it's easy with hindsight, but if you follow the line of thought, and the double-whemy monetary line of thought I just followed was to be somehow expected. Now you are in the middle of it. Most likely, you will get, I would say, another lag of weakness upcoming.

• 1:04:17Speaker 02

  Once that is cleaned and the bond market is stabilized, that should happen- Roughly in the second half of next year, I would expect that the labor market has already taken a large hit enough and inflation is slowing down enough that the Federal Reserve can be more accommodative. So when that happens, as you go into 2024, you will have a completely different setup. You will have also what I call the tourists of an asset class being flushed away. People that are in the asset class because it's a momentum thing. It's not something they really understand or they are comfortable with. It's just a momentum play. Those would have been completely washed out and the set of macro circumstances will look much more favorable for risk assets in general, including digital assets at that point.

• 1:05:01Speaker 02

  But unfortunately, I can't see that happening much earlier than late 2023 unless, if I am proven wrong, the Federal Reserve decides to stop tightening the screws much earlier than what I expect. But that would mean that inflation has already slowed down or that the Federal Reserve is happy with inflation at 6% or at 5%. And I don't think they will be happy because it doesn't fit their mandate. It doesn't make regain any credibility to the central bank itself.

• 1:05:29David Hoffman?

  So I think this fits into the broader conversation of like, when pivot Fed? Like Fed, please pivot so my assets can go up in price. What I heard from you is 2023 is just going to be a year of flat, maybe down. But like it kind of, you kind of painted a picture of like, well, there is a timer on eventually the quote Fed will pivot. What's going to make the Fed pivot though? Like, what are the indicators that we're really going to be looking for?

• 1:05:58Speaker 02

  So there are two ways to pivot and neither of those is a good one, which is there is a systemic liquidity crisis that will make the Fed pivot between brackets. If the base of the pyramid is at risk of being destroyed, then the pyramid wouldn't exist anymore and nobody wants that, policymakers included, so that makes sure that that doesn't happen. Now, that kind of systemic risk means a blow up in the repo market or treasury markets being completely dysfunctional or the repo market blow up. We haven't really seen any major evidence yet. The treasury market is becoming a bit more illiquid. It's a function of volatility. If it's so volatile, how can you expect it to be very liquid as well?

• 1:06:44Speaker 02

  Were that to happen, the Federal Reserve would need to intervene, very similar to what the Bank of England did when the UK pension fund industry was about to blow up as well.

• 1:06:54Speaker 02

  But that means we are witnessing large systemic risks. Liquidation in risk assets, people need collateral, they will be liquidating any asset they have first in a panic mode until the Federal Reserve intervenes, which means that probably risk assets will have to have a drawdown before the Federal Reserve intervenes. So it's a delayed Fed pivot that doesn't really help price action before they actually get there. And the second way to pivot would be if the labor market gets hit so bad that inflation starts to slow down and people are losing their job and they can't spend money anymore. And the Federal Reserve is like, okay, maybe we did enough damage, we can slow down a little bit. And that would be translated into, you know, better risk sentiment six to nine months ahead. Now, that I think is the most likely path ahead, which makes me want to think that

• 1:07:40Speaker 02

  we're going to see some pain through the real economy and risk assets still between now and the first half of next year. And then, you know, going into the second half of next year, I think the set of circumstances will be more friendly for the Federal Reserve to pivot, credibly pivot, not because they want to rescue some asset class. I'm sorry, they don't care about where the equity market is, if it's three and a half or 3.9. Actually, they care, negatively care, if it keeps rallying, because it defeats the purpose. They want demand to slow down. How will demand slow down if people see their 401Ks going through the roof? They will be probably spending more. So they need the labor market to slow down, risk assets to be really contained

• 1:08:24Speaker 02

  in order for these lagged effects of tighter, double whammy monetary withdrawal to feed through the economy. And only when enough damage is done, they can credibly pivot back.

• 1:08:34Ryan Sean Adams?

  The picture you're painting sounds like the Fed is only going to pivot at the last available moment and not a moment sooner than that.

• 1:08:42Speaker 02

  Imagine, David, they are driving their car, looking in the rearview mirror instead of looking in the front window. And that's how they're driving their car. They're looking at the moment when inflation will slow down. Well, inflation is the most lagging indicator of all available. I mean, I rank them by leading, coincident, lagging. Inflation is amongst the most lagging of all, which means basically they're driving and they're looking back rather than looking in front. That's by design. That's because of their incentive scheme and their mandate is to slow inflation. And they've been so wrong that they cannot accept any nuance anymore. They'll be like, I don't care. I know I'm gonna make damage.

• 1:09:24Speaker 02

  Again, quoting Powell, households will need to go through some pain. Those are the unfortunate consequences, which means I fucked up. Now I need to regain my credibility and I will be driving, looking in the rearview mirror.

• 1:09:36Ryan Sean Adams?

  I hope Powell can drive this economy like James Bond then because it's pretty difficult to drive that way. Alpha, let's zoom out. Okay, so we talked a lot about the cycle, but I want to get back to this conversation that you mentioned earlier of like, hey, we've been doing these cycles, these kind of oscillating debt cycles for the last 40 years. And we don't live in the 1980s anymore. This is the 2020s. And with real productivity declining across kind of the modern world, where is the next leg of growth actually going to come from? And I want to bring in, you know, another analogy

• 1:10:18Ryan Sean Adams?

  that we've seen in the macro world, which is, you know, Ray Dalio's long-term debt cycles and this concept of you have kind of this 80 to 150-year period of time where there is some established monetary order, like a new world order. The world order that we're living in is kind of like the post Bretton Woods, post-World War II, new order set up in like the 1940s, the late 1940s. You had this era of prosperity and you had debt cycles and then a big wealth gap and debt burst. That's kind of the peak. On the other side of that, you get printing money and credit, revolutions and wars, a lot of political instability, debt and then political restructuring and then new world order and then it then it plays again.

• 1:11:01Ryan Sean Adams?

  The shorter term cycles that you're talking about, you know, Dalio describes that, well, these shorter term cycles kind of just oscillate around this long term debt cycle. And so I guess my first, my question is, is this kind of the the rough mental model that you use for thinking about the long term? And then like, so how many more cycles do we have, mini cycles do we have until this full debt cycle plays out? And we have to go all the way back to the base layer and establish a new world order?

• 1:11:34Speaker 02

  Very good questions, Ryan. And yes, I think along the same terms, but I visualize this a little bit differently. Instead of this bell curve that you just showed from Dalio as a long term trend, I tend to think of growth and inflationary long term trends. And so they look like a straight line up with an angle of growth that really depends on at which point in the structural long term cycle are you in? And so this, this was a very acute, acutely sloping, positively sloping long term line in the eighties, because structurally we were growing very strong and we discussed about demographics and productivity. And now the slope of this curve is kind of flatlining very aggressively all over the world, right?

• 1:12:18Speaker 02

  And then around this line, you have cycles. You have cycles that dictate the macro cycle we are in. And those are interplaying with each other, but they're really a separate thing. One lasts roughly 12 to 18 months, while the slope of these long term lines actually changes maybe over a decade, not earlier than that. So right now I see the long term trend basically for growth and inflation being nominal growth in general being pretty flat, right? And the cycles around being now a downward cycle. Now, the problem becomes when the long term trending line for nominal growth becomes effectively flat. And that's basically, I think, the roadmap is Japan for that.

• 1:13:01Speaker 02

  So Japan had a very upward sloping curve, good demographic, good productivity until the seventies, and then demographics started slowing down and productivity too, and they started printing money and credit like there was no tomorrow. And that was the real estate bubble in Japan in the late eighties, beginning of the nineties, when the Imperial Palace of Tokyo was worth more than California. Okay, so just to give you an example of how much that bubble was going fast. Now that bubble burst, and what happened then, you would expect, right, Ryan, is that you go towards Dalio's low end of that chart, which is a restructuring of some sort. You need to have social unrest, basically, that leads to a restructuring of some sort.

• 1:13:45Speaker 02

  Have we had one in Japan? Not really. We remain stuck in that printing money and credit kind of thing forever, over and over again, and it's been over thirty years that Japan has been in that situation, if you think about that. The US or Europe, not Japan, for a bunch of reasons. So there are also cultural things that come to play here, where in Japan, people are coming out of retirement and trying to work more hours to make sure that they can contribute to economic growth, and I can't really imagine the US or Europe going toward the same cultural cohesion kind of path, right? So the situation is much more culturally fragile in the Western economies. It's very hard to predict exactly when, but social unrest, I do agree with Dalio there,

• 1:14:29Speaker 02

  is one of the things, one of the indicators that something is brewing under the surface, where people are becoming tired of these iterations, because we're talking about iterations. We're trying to fix a slope that is becoming flat by iterating the same cycle all over and over again. And as you correctly pointed out before, sometimes it's a higher top and a lower bottom, which makes people very uncomfortable with this cycle in the first place, and the wealth inequality makes them feeling not particularly rewarded by this cycle in the first place. And social unrest, there have been plenty of episodes already happening. I can take Europe as an example, where... At every election, you get a more extremist government. Being left or right, you get anyway people voting for something new,

• 1:15:14Speaker 02

  something that sounds a new promised land that will break this cycle. So far, we haven't reached the breaking point, but the more you proceed ahead, especially in Western economies where there is less cultural cohesion towards sacrificing its own good for the public good, let's say, maybe a bit like Japan does, it makes the situation more inherently fragile. And it's hard to say exactly when, but we are definitely walking towards that path ahead of us. With social unrest, I think, being one of the most evident signals that that's already happening.

• 1:15:45Ryan Sean Adams?

  Is this where kind of the probabilistic analysis comes in of like, what's the probability that we get one more of these kind of cycles before everything breaks and there's a big reset? Or two more or three more? That's probably impossible to say precisely in the way that you can more accurately predict the shorter term cycles. But it does seem like we are, I don't know, it's 10:00 PM, two hours till midnight kind of thing. Like the clock is ticking and it's getting later in this cycle. Would you say this? And then also Alf, like, how do we get out of it? Is there a way to actually transition peacefully? Or is this just not the way of human beings?

• 1:16:25Speaker 02

  There is no new world order or a transition to something that doesn't exist that involves power? Because that's what we're talking about. We're talking about transferring power from one source to another. And there is no transmission of power that goes on in a very friendly way in history that I'm aware of. Right? So that is by definition. And the last comment I want to say is that there is one thing of the engine that suggests to me that we are relatively late in that kind of long-term cycle clock. That is the fact that in order to make this cyclical boost, boom and bust, basically, small cycles within long-term trend, you need credit to be cheaper at every iteration.

• 1:17:09Speaker 02

  You need debt to become accessible, that cheaper rates to everybody at every iteration. Think about the housing market. If salaries are not growing and you want the housing market to grow 10% a year, the only way to do that is by making the new mortgage. Actually cheaper than the old one. So you borrowed at two percent a house worth five hundred thousand. If the next guy can borrow at zero percent, all of a sudden that house is worth much more, simply because you're lower borrowing rates, not for any other reason. Salaries haven't really changed, right? This iteration tends to stop when you go, when you reach interest rates at zero percent. So Japan hasn't been able to engineer this credit booms anymore because rates have been at zero forever.

• 1:17:52Speaker 02

  So the next marginal buyer doesn't have more power. He has exactly the same borrowing rate that the guy before him had. And so house prices in Japan in real terms have grown by zero percent for basically ten years. So this wealth generation effect, this cyclical credit boost, booms that we do, become more difficult when interest rates are pinned and you can't really lower interest rates for the next borrower to feed this cyclical credit upswing. Now, we have gone very close to that point in Europe and in the U.S. And now we have a room where rates are very high because we need to fight inflation. I do expect Fed funds rate to be below one percent in twenty twenty four, which will

• 1:18:31Speaker 02

  make the new credit iteration, the new credit, new credit cycle, marginally more difficult at every iteration, till you reach a point where, yeah, you want to generate credit, but the rates are already at zero percent. Where are you going to bring them? Which makes the new borrower less powerful on the margin, let's say. So, so this cycle tends to become a bit less powerful than it was in the past. And this might be a breaking point, actually. And if I'm right on that, I think the next decade or two might prove to be more difficult to engineer with the same model than the last forty years were.

• 1:19:08Ryan Sean Adams?

  Elf, one other, I guess, crypto utopian perspective is the potential and the promise of technology. I mean, we are big believers, obviously, in the technology to drive improvement. I remember reading, listening to a podcast from Tyler Cohen, who's an economist in the U.S. And he wrote this book called Stubborn Attachments, where he makes the case that in order to have a peaceful society that exists, or a democracy of any kind. You actually need growth because if you have negative growth, everything fractures. People start talking about how to split the pie rather than grow the pie. And you have political divide and you have division, which leads to wars, the civil kind or wars of other countries and the election of autocrats and everything that falls from that.

• 1:19:52Ryan Sean Adams?

  So growth isn't imperative. And as you look at kind of like the, the true productivity levers when in sort of your, your macro exploration, how do we actually generate productivity in a world where we've got declining demographics, for example? I mean, I, some pockets of the world have better demographics, you know, Africa, some emerging markets, certainly. So maybe there's hope there. But in the, in kind of the, the fully emerged world, Western democracies and such, is our way out technology? Is that the only way we actually achieve positive, real economic growth? And is there a story there? Is there some hope that you see in the numbers from this?

• 1:20:33Speaker 02

  Yeah, so there are two ways. One would be a 2022 industrial revolution of some sort where instead of industrial revolution, you basically have a new discovery that all of a sudden changes the, the productivity slope completely, like, like it was for the industrial revolution, for example, and the invention of, of the motor back then. Now, the, today, I mean, what's the probability of that? I don't know. It's a one-off event, very low probability, high impact event that we have a discovery of some sort that boosts productivity all of a sudden. The other way to boost productivity growth over time is to make sure that technology permeates as many sectors of the economy as possible.

• 1:21:16Speaker 02

  And today, the economy is service-based for roughly 70% of our output, which means that the technology has most likely already permeated a lot of the services sector. I mean, look at us, you guys are in the US, I'm in Europe, we're having a chat over, I don't know, whatever riverside we're using, but any, any.

• 1:21:35Ryan Sean Adams?

  1080p, high def, fidelity, yeah.

• 1:21:38David Hoffman?

  Feels like you're sitting right across from me, Al.

• 1:21:40Speaker 02

  Yeah, there you go. So that kind of technology, one might argue, has already decently permeated the service sector, not all the service sector, but to a certain extent, yes. Which also, when I hear that technology is going to increase productivity, I'm like, where is the marginal gain going to come from? You will be increasing your productivity, yes, you will. Every year productivity in the US grows by roughly 1%, more or less, maybe a bit more. If you want a productivity boost that more than offsets the population decline, demographics, headwinds we have ahead of us, we need some sort of one-off boost, which might happen,

• 1:22:20Speaker 02

  but I find that to be a low-probability event, high-impact event, that is very, very hard to predict.

• 1:22:26Ryan Sean Adams?

  Alf, was the internet such a... you talked about the Industrial Revolution, which is beyond the, obviously, the age or time range of anyone listening, but how about the internet? That is a major innovation. Did that show up in the numbers of increasing productivity?

• 1:22:41Speaker 02

  It could. It could, especially if it would unlock some potential that is, for sure, unfortunately, very undertopped and underused, especially in certain parts of the world, that had not much access to productive internet over the last decade. So that could be actually one way to untap some productivity growth which haven't been there. I only wonder whether those will be systematically important to offset the, basically, certain demographic headwinds that we have ahead of us. If I look at labor force growth over the next 20 years, most Western economies, and China included, by the way, will have their population,

• 1:23:21Speaker 02

  their working population decline. So the pie, when it comes to people contributing to economic growth, that pie actually is getting smaller. So we not only need productivity, but we need fast productivity to more than offset that working population drop, and that's going to be quite a hard task, I think.

• 1:23:40Ryan Sean Adams?

  Lots of headwinds ahead for us, Alf, but I think there is hope while we remain building and while we have these open conversations about these topics and stay educated. I mean, in previous events like this throughout history, very hard to find someone as knowledgeable as yourself to actually talk about these issues. So it's a big step in our ability to actually keep ahead and be educated on topics like these. And Alf, I want to thank you for making some time for us today. I guess, do you have any closing thoughts for Bankless listeners? Anything you'd summarize for us?

• 1:24:14Speaker 02

  Yes, I would say macro is important for investors in all asset classes, and 2022 has proved to be exactly a very clear example of that. And macro might sound scary. I know that. I understand that. It's full of jargon. It's very complex, but it's beautiful. You need to get your hands dirty into monetary mechanics, how money works, how economies interact with each other. And understanding macro is an exercise of basically trying to put together a never-ending puzzle. It's always a discovery. It's a learning journey, effectively, that will make you a smarter investor, whatever asset class you're involved in, including digital

• 1:24:56Speaker 02

  assets. I think macro is so important and has been so underrated for so many years. I'm happy to a certain extent that this environment has been so macro-volatile that voices like mine, but not only mine, there are plenty of good guys out there and girls, are now getting to share some of the knowledge that I have or we have accumulated when, especially me, working in the institutional setup, having the chance to talk to prime ministers, central bankers, understanding their thinking, talking to hedge funds, being a portfolio manager myself. I encourage every Bankless listener to try and get themselves more into macro because it's the place to be to understand really what's going on and getting an edge also in the digital asset space.

• 1:25:41Ryan Sean Adams?

  100% agree. I think Bankless listeners, you got to add macro to your portfolio of skills in this space. And Alf, thank you for simplifying some of these contexts for us today. We appreciate you.

• 1:25:50Speaker 02

  It's been my pleasure to be here. Thank you, guys.

• 1:25:52Ryan Sean Adams?

  Some action items for you, Bankless Nation. Number one, you got to check out Macro Elf's blog. That's at themacrocompass.substack.com. We'll also include a few goodies for you in the show notes, including a link to the global credit impulse cycle that we talked about during this episode. And Elf's post, is it 20, is it 2001 again? That's the big question. We got into that post called "Back to 2001." That's free for everyone, of course. Risks and disclaimers. Macro is risky right now, but so is crypto. Everything is, I guess, in the world today. But especially crypto, especially DeFi, you could definitely lose what you put in. None of this has been financial advice. As usual, we're headed west. This is the frontier. It's not for everyone, but we're

• 1:26:37Ryan Sean Adams?

  glad you're with us on the Bankless journey. Thanks a lot.

• 1:26:40David Hoffman?

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• 1:27:23David Hoffman?

  we summarize the week in crypto and other fantastic content. Thanks, everyone, for watching and being on the journey as we build out the Bankless Nation.